Demonetisation: A Failed Financial Dialysis

Tuesday 31 January 2017

by V. Mathew Kurian

Money to the economy is like blood to our human body. Circular flow of money is exactly similar to the circulation of blood in our biological system. When we lack adequate blood, we become anaemic and vulnerable. In the economy also, sufficient money supply is required to ensure its healthy functioning. When some illness happens to our kidney, the circulating blood gets toxic and dialysis is resorted to in order to purify it. But before resorting to this therapy, several investigations and precautionary measures are taken. Demonetisation may be considered as ‘financial dialysis’ to make circulating money legally sound.

On November 8, 2016 at 08.15 pm Narendra Modi, our Prime Minister, resorted to a ‘financial dialysis’ by making 86.4 per cent of total money in circulation null and void. With the so-called ‘surgical strike’, the Government of India made the then circulating Rs 500 and Rs 1000 notes not ‘legal tender’. Subsequently, Modi put forward a new argument that this would help India to get elevated to the rank of a ‘cashless society and economy’.

The displaced notes were replaced by new Rs 500 and Rs 2000 notes. But the supply of these notes was inadequate to compensate the ‘cash crunch’ due to demonetisation. Further, from a liquidity point of view, Rs 2000 notes were found ill-suited to satisfy the transactions demand of money. As the government failed to take the required planning and precautions, people in general were subjected to severe pain in their ordinary life. Quite aware of this predicament, the Prime Minister wanted 50 days to bring the monetary and financial system back to order. Now that time has elapsed.

People expected much from the New Year speech of the Prime Minister to tackle the grave crisis due to demonetisation. But instead of addressing it, he befooled the entire people of India by just declaring some marginal welfare measures, which we expected in the Budget speech of the Finance Minister.

Demonetisation has already inflicted a multi- dimensional impact on the economy and society of India. The following is a brief analysis of it.

1. The Impact on Vulnerable Sections:

India is a country where vast sections of people are still socially and economically vulnerable. They eke out their daily subsistence income by just exchanging their labour power, especially in the informal sector. If they are denied of daily employment, they lose their subsistence as they have no other source of income. Owing to currency crunch, there was a cut in employment in rural as well as urban informal sectors which led to massive ‘entitlement failures’.

2. The Impact on Agriculture:

Demonetisation has posed two types of grave threats to Indian agriculture. Firstly, the demand threat. This measure was imposed at a time when farmers had to dispose of their final produce. Paucity of money adversely affected the demand for agricultural crops which led to a terrific fall in farmers’ incomes. It is also going to affect adversely the future development of our agriculture as the farmers presently lack income to procure the requisite inputs for the next season. Already, Indian agriculture is notorious for farmers’ suicides. Demonetisation is going to aggravate such phenomena.

3. The Impact on Co-operative Organisations:

Alleging cooperative banks as financial institutions supporting black money, the government excluded them from ‘remonetisation’. As these banks are predominantly poor-friendly, it also added to hardships to the marginal sections. Further, it has also created a crisis of confidence of the stakeholders in this important financial segment of the Indian economy. States like Kerala have been hard hit by this measure.

4. The Impact on Economic Growth:

In the last few years, the Indian economy was growing faster (next to the Chinese) than most of the national economies of the world, in spite of the global financial crisis. But this ill-prepared monetary measure is going to affect adversely the tempo of economic growth. More than two per cent cut in the GDP growth rate is predicted by the evaluation agencies as well as reputed economists in the coming financial year. Already the recessionary trend is visible in the economy.

5. The Fiscal Impact:

When there is allround slowdown in economic activities, it would negatively affect the revenue raising capacity of the government, both at the Centre and State levels. This could cause a fiscal crisis. So there is every likelihood of increasing fiscal and revenue deficits in the coming budgets.

6. The Impact on the External Value of Rupee:

As an outcome of demonetisation, the external value of the Indian rupee is showing a declining trend. On November 8, the exchange rate between American dollar and Indian rupee was 66.70. But on December 30 it has become 68.12.

7. The Impact on Foreign Capital and Inward Remittances:

When the economy is slowing down profit-oriented foreign investors would be reluctant to invest in India. This would negatively affect the inflow of direct private foreign capital. As the Federal Reserve System of America hiked the interest rate, there is also every possibility of foreign institutional investors withdrawing portfolio capital from India. When the expatriate Indians see an insecure Indian rupee, there is also the chance of negative impact on foreign remittances. All these might cumulatively cause a balance of payments crisis in the near future.

8. The Political Impact:

Economists like Amartya Sen considered this act as deprivation of freedom of the Indian people. To Sen, this is “despotic action that has struck at the root of (our) economy based on trust”.

We conclude this brief note by quoting Amartya Sen: ‘Only an authoritarian govern-ment can calmly cause such misery to the people—with millions of innocent people being deprived of their money and being subjected to suffering, inconvenience and indignity in trying to get their own money back.”